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Investment Strategies for Business Owners

In a recent whitepaper titled “Asset Allocation and the Business Owner: Is Your Wealth Management Strategy Ignoring your Biggest Asset?”, authors Christopher Didier and Brian Beaulieu address the risk that business owners face by tying up the vast majority of their wealth in their businesses. While typical portfolio management theory would suggest that diversifying assets is a safer path, the authors argue that sometimes it makes sense not to diversify. In particular, when business owners are trying to grow their businesses, the argument can be made that money is best invested in the business to ensure its long term viability. However, as the business matures, many family business owners move into wealth preservation, rather than wealth creation mode. At this point, owners need to consider how much money they have invested in their business and the risk they take on if they do not diversify their holdings.

Many business owners neglect diversification because they feel they are diversified within their business. And, family businesses often do a good job of buying into a wide range of businesses or holding assets such as real estate within the business to serve as a source of diversification. The mistake that business owners make, according to the authors, is that they do not consider their overall financial holdings as they attempt to reduce risk. Business owners who have harvested money from their businesses to invest in other areas should look at their overall investment portfolio, including their businesses and passive investments.

One reason this important aspect of risk management is overlooked is that investment professionals often ignore business assets when making investment allocations. The business is left out of the allocation for several reasons:

Businesses are hard to compare to other investments. Often family businesses are highly specialized or operate in niche markets, so there are no public comparisons, which are needed to assess volatility or risk.

Private company investments are illiquid. Due to the inability, or lack of willingness, to sell these assets, the argument could be made that they should not be considered part of the investment portfolio.

Business owners are highly familiar with the business environment in which they operate. Sometimes this familiarity can lead to a sense of over-confidence that they environment can be controlled, when in reality it cannot. Business owners who feel they have control over the environment may not feel a need to diversify because they think they avoid a downturn in their core business.

Family business owners with significant wealth outside the business often use a large group of professionals to manage outside investments. While these professionals may represent the cream of the crop in their respective areas, if they are not coordinated, they cannot develop a sound diversification strategy.

The authors suggest three steps that can be used to incorporate the family business asset into broader investment allocation decisions:

Create a business market index. This index compares the owners company to others with similar business cycles to predict how your business will react in various economic environments.

Create a correlation matrix. The matrix correlates your business performance with other investments, or asset classes. For instance, does your business tend to behave in the same way that foreign equities behave when the economy slows. If so, you shouldn’t invest heavily in this asset class.

Balance your risks. Once the business owner identifies how assets classes behave in comparison to his business, he can invest in classes that are not correlated. For instance, if a business owners’ profitability in tied to commodity prices, such that when commodity prices rise his profits decline, he should consider investing in some commodities to balance out the impact on his business.

The authors sum up their thesis in one sentence – “If your business is one of your biggest assets and it has not been adequately considered in your wealth management strategy, perhaps it is time you consider it.”

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